Understanding Michael Porter

🚀 The Book in 3 Sentences

This book is a condensed and high-level walkthrough of the works of Michael Porter the strategist. It goes through the five forces, how to understand business and companies. It shows how to understand the business and its advantages and disadvantages.

🎨 Impressions

The five forces framework is important when it comes to understanding how a market and businesses behave

The missing middle phenomenon is important, where companies either tend to differentiate into high-end markets or low end markets slowly over time.

✍️ My Top Quotes

• Very early in his career, he went after the single biggest and most consequential question in business: Why are some companies more profitable than others?

• The thing about classics, as Mark Twain once observed, is that they are often books “that everybody wants to have read and nobody wants to read.”

• “The essence of strategy,” Porter often says, “is choosing what not to do.”

• Porter’s prescription: aim to be unique, not best. Creating value, not beating rivals, is at the heart of competition.

• The second part is attributable to the company’s relative position within its industry. Strategic positioning reflects choices a company makes about the kind of value it will create and how that value will be created. Here, competitive advantage and the value chain are the relevant frameworks.

• The first part is attributable to the structure of the industry in which competition takes place.

• STRATEGY IS ONE OF the most dangerous concepts in business. Why dangerous? Because while most managers agree that it is terrifically important, once you start paying attention to how the word is used you will soon be wondering whether it means anything at all.

• Strategy explains how an organization, faced with competition, will achieve superior performance.

• Michael Porter has a name for this syndrome. He calls it competition to be the best. It is, he will tell you, absolutely the wrong way to think about competition. If you start out with this flawed idea of how competition works, it will lead you inevitably to a flawed strategy. And that will lead to mediocre performance.

• In the vast majority of businesses, there is simply no such thing as “the best.”

• This, says Porter, is competitive convergence. Over time, rivals begin to look alike as one difference after another erodes. Customers are left with nothing but price as the basis for their choices.

• Companies only have to be “big enough,” which rarely means they have to dominate. Often “big enough” is just 10 percent of the market. Yet companies under the influence of winner-takes-all thinking tend to pursue illusory scale advantages.

• When choice is limited, value is often destroyed.

• Strategic competition means choosing a path different from that of others.

• The real point of competition is not to beat your rivals. It’s to earn profits.

• The five forces framework zeroes in on the competition you face and gives you the baseline for measuring superior performance.

• Because there are no coherent economic principles underlying SWOT, you end up with random lists of items under each of the four headings, depending on who is in the room and what issues are top of mind that morning.

• Unit Profit Margin = Price – Cost Costs include all of the resources used in competing, including the cost of capital. These are the resources that the industry transforms to create value. Prices reflect how customers value the industry’s offerings, what they are willing to pay as they weigh their alternatives.

• If you have powerful buyers (that is, customers), they will use their clout to force prices down.

• Powerful buyers will force prices down or demand more value in the product, thus capturing more of the value for themselves.

• Both industrial customers and consumers tend to be more price sensitive when what they’re buying is Undifferentiated Expensive relative to their other costs or income Inconsequential to their own performance A counterexample that includes all three of these conditions is the price insensitivity of makers of major motion pictures when they buy or rent production equipment.

• Powerful suppliers will charge higher prices or insist on more favorable terms, lowering industry profitability.

• Doctors and airline pilots, to cite two examples, have historically exercised tremendous bargaining power because their skills have been both essential and in short supply.

• For decades, OPEC, the Organization of the Petroleum Exporting Countries, has fended off substitutes by carefully managing the price of oil to discourage investment in alternative forms of energy.

• Substitutes—products or services that meet the same basic need as the industry’s product in a different way—put a cap on industry profitability.

• The threat of entry dampens profitability in two ways. It caps prices, because higher industry prices would only make entry more attractive for newcomers. At the same time, incumbents typically have to spend more to satisfy their customers. This discourages new entrants by raising the hurdle they would have to clear in order to compete.

• Entry barriers protect an industry from newcomers who would add new capacity.

• Does producing in larger volumes translate into lower unit costs? If there are economies of scale, at what volumes do they kick in? The numbers matter.

• When rivalry among the current competitors is more intense, profitability will be lower. Incumbents will compete away the value they create by passing it on to buyers in lower prices or dissipating it in higher costs of competing.

• If rivalry is intense, companies compete away the value they create, passing it on to buyers in lower prices or dissipating it in higher costs of competing.

• Price competition, Porter warns, is the most damaging form of rivalry. The more rivalry is based on price, the more you are engaged in competing to be the best.

• The five forces framework applies in all industries for the simple reason that it encompasses relationships fundamental to all commerce.

• It matters that you grasp the deeper point: there are a limited number of structural forces at work in every industry that systematically impact profitability in a predictable direction.

• Managers often mistakenly assume that a high-growth industry will be an attractive one. But growth is no guarantee that the industry will be profitable.

• Finally, complements are sometimes proposed as a “sixth force.” Complements are products and services used together with an industry’s products—for example, computer hardware and software. Complements can affect the demand for an industry’s product (would you buy an electric car if you had no place to plug it in?), but like the other factors under discussion—growth, government, technology—they affect industry profitability through their impact on the five forces.

• Competitive advantage is not about trouncing rivals, it’s about creating superior value.

• If you have a real competitive advantage, it means that compared with rivals, you operate at a lower cost, command a premium price, or both.

• Growth is another widely embraced goal, along with its sister goal, market share. Like ROS, these fail to account for the capital required to compete in the industry.

• In industrial markets, value to the customer (which Porter calls buyer value) can usually be quantified and described in economic terms. A manufacturer might pay more for a piece of machinery because, compared with lower-priced alternatives, it will produce offsetting labor costs that exceed the higher price.

• I once calculated, for example, that consumers were effectively paying well over $100 an hour for the unskilled labor involved in grating cheese.

• Strategy choices aim to shift relative price or relative cost in a company’s favor.

• The sequence of activities your company performs to design, produce, sell, deliver, and support its products is called the value chain. In turn, your value chain is part of a larger value system.

• Start by laying out the industry value chain. Every established industry has one or more dominant approaches. These reflect the scope and sequence of activities that most of the companies in that industry perform, and this is as true for nonprofits as for any business.

• You begin to see each activity not just as a cost, but as a step that has to add some increment of value to the finished product or service.

• Porter uses the phrase operational effectiveness (OE) to refer to a company’s ability to perform similar activities better than rivals. Most managers use the term “best practice” or “execution.” Whichever term you prefer, we are talking about a multitude of practices that allow a company to get more out of the resources it uses. The important thing is not to confuse OE with strategy.

• *In this section of chapters, we’ll cover five tests every good strategy must pass:

  • A distinctive value proposition
  • A tailored value chain
  • Trade-offs different from rivals
  • Fit across value chain
  • Continuity over time

• *Porter defines the value proposition as the answer to three fundamental questions:

  • Which customers are you going to serve?
  • Which needs are you going to meet?
  • What relative price will provide acceptable value for customers and acceptable profitability for the company?

• The value proposition is the element of strategy that looks outward at customers, at the demand side of the business. The value chain focuses internally on operations. Strategy is fundamentally integrative, bringing the demand and supply sides together.

• The Enterprise value proposition is based on a simple insight: renting a car meets different needs at different times.

• Early in his career, Porter identified a set of generic strategies—focus, differentiation, and cost leadership—that quickly became one of the most widely used tools for thinking about key strategic choices.

• Focus refers to the breadth or narrowness of the customers and needs a company serves. Differentiation allows a company to command a premium price. Cost leadership allows it to compete by offering a low relative price.

• At the same time, Porter described a common strategic mistake, which came to be known as getting stuck in the middle. This happens when a company tries to be all things to all customers and is outflanked by cost leaders on one side, who meet “just enough” of their customers’ needs, and by differentiators on the other side, who do a better job of satisfying customers who “want more” (of some particular attribute they value).

• Enterprise’s strategic insight was that its particular value proposition would require a completely different value chain from a Hertz or an Avis.

• Choices in the value proposition that limit what a company will do are essential to strategy because they create the opportunity to tailor activities in a way that best delivers that kind of value.

• To establish a competitive advantage, a company must deliver its distinctive value through a distinctive value chain. It must perform different activities than rivals or perform similar activities in different ways.

• “Strategic competition,” Porter writes, “can be thought of as the process of perceiving new positions that woo customers from established positions or draw new customers into the market.”

• Porter’s first two tests of strategy: a unique value proposition and the tailored value chain required to deliver it.

• If there is one important takeaway message, it is that strategy requires choice. Competitive advantage depends on making choices that are different from those of rivals, on making trade-offs. This is Porter’s third test. Trade-offs play such a critical role that it’s no exaggeration to call them strategy’s linchpin. They hold a strategy together as they contribute to both creating and sustaining competitive advantage.

• Trade-offs are the strategic equivalent of a fork in the road. If you take one path, you cannot simultaneously take the other.

• An intriguing recent study has found a so-called IKEA effect: that self-assembly actually raises, not lowers, the price consumers would be willing to pay.

• If you have a strategy, you should be able to link it directly to your P&L.

• Porter calls what McDonald’s tried to do straddling, and it is the most common form of competitive imitation. The straddler, as the word implies, tries to match the benefits of the successful position while at the same time maintaining its existing position.

• British Airways took this lesson to heart: if you’re going to occupy two distinct positions in the same business, the only way to bypass the trade-offs is to create a separate organization with the freedom to choose its own, tailored value chain. BA’s experience shows that even when you do that, it is still a very hard act to pull off.

• After racking up somewhat-higher-than-expected losses, BA decided that running a low-cost airline was inconsistent with its positioning as a premium carrier. It sold Go to private equity firm 3i. Free from BA, Go launched an aggressive advertising campaign explicitly targeting BA customers. Only a year later, 3i was able to sell a larger Go to low-cost rival EasyJet at four times the price it had paid for the company.

• Trade-offs are choices that make strategies sustainable because they are not easy to match or to neutralize.

• When you try to offer something for everyone, you tend to relax the trade-offs that underpin your competitive advantage.

• Executives often resist making trade-offs for fear they will lose some customers. The irony is that unless they make trade-offs and deliberately choose not to serve all customers and needs, then they are unlikely to do a good job of serving any customers and needs.

• Good strategies depend on the connection among many things, on making interdependent choices.

• Fit means that the value or cost of one activity is affected by the way other activities are performed.

• Common mistake in strategy is to choose the same core competences as everyone else in your industry.

• “We got good ideas from corporate . . . Each idea would come, falter, and go, and in six months there would be another idea. After a while we stopped believing in the ideas.”

• In 1850, Paul Julius Reuter found an ingenious way to speed the delivery of global financial information to market participants. His new technology was the carrier pigeon. The company Reuter founded survives to this day, although the pigeons gave way to a series of technological innovations, beginning with the telegraph and culminating in the Internet.

• In Porter’s view, these so-called inflection points are relatively rare, and companies are more likely to pull away from their strategies prematurely.

• Since the 1990s, leading change has become the hallmark of a great CEO. The principle of continuity reminds us, however, that not all change is good, that too much change can be bad, and that not all change requires a change in strategy.

• Paradoxically, continuity of strategy actually improves an organization’s ability to adapt to changes and to innovate.

• The deliberate and explicit setting of strategy is more important than ever during periods of change and uncertainty.

• What Porter asks of managers is both very simple and very hard. He asks, simply, that managers keep a clear line of sight between their decisions and their performance. But, he says, no cheating allowed—you must be precise and rigorous about it.

• Ten Practical Implications Vying to be the best is an intuitive but self-destructive approach to competition. There is no honor in size or growth if those are profitless. Competition is about profits, not market share. Competitive advantage is not about beating rivals; it’s about creating unique value for customers. If you have a competitive advantage, it will show up on your P&L. A distinctive value proposition is essential for strategy. But strategy is more than marketing. If your value proposition doesn’t require a specifically tailored value chain to deliver it, it will have no strategic relevance. Don’t feel you have to “delight” every possible customer out there. The sign of a good strategy is that it deliberately makes some customers unhappy. No strategy is meaningful unless it makes clear what the organization will not do. Making trade-offs is the linchpin that makes competitive advantage possible and sustainable. Don’t overestimate or underestimate the importance of good execution. It’s unlikely to be a source of a sustainable advantage, but without it even the most brilliant strategy will fail to produce superior performance. Good strategies depend on many choices, not one, and on the connections among them. A core competence alone will rarely produce a sustainable competitive advantage. Flexibility in the face of uncertainty may sound like a good idea, but it means that your organization will never stand for anything or become good at anything. Too much change can be just as disastrous for strategy as too little. Committing to a strategy does not require heroic predictions about the future. Making that commitment actually improves your ability to innovate and to adapt to turbulence.

• The granddaddy of all mistakes is competing to be the best, going down the same path as everybody else and thinking that somehow you can achieve better results. This is a hard race to win. So many managers confuse operational effectiveness with strategy.

• Another mistake is to overestimate strengths. There’s an inward-looking bias in many organizations. You might perceive customer service as a strong area. So that becomes the “strength” on which you attempt to build a strategy. But a real strength for strategy purposes has to be something the company can do better than any of its rivals.

• The worst mistake—and the most common one—is not having a strategy at all. Most executives think they have a strategy when they really don’t.

• Capital markets have become toxic for strategy. The single-minded pursuit of shareholder value . . . has been enormously destructive for strategy and value creation.

• The pressure to grow is among the greatest threats to strategy.

• Making trade-offs often turns out to be harder for managers in nonprofits.

• Strategic planning often becomes a time-consuming ritual that really doesn’t support strategic thinking at all.